Can you have too much income from dividends?

Can you have too much income from dividends?

Long-time readers of this site know I take a two-pronged approach to investing.  I own a number of Canadian dividend paying stocks for income (and long-term growth) (about 30 in all) however I also own a few U.S. dividend paying stocks for income, growth and a couple of low-cost U.S.-listed ETFs for greater diversification.  You can read about those holdings including what I put where in more detail here and here.

As a follow-up this article on my site about having a fat RRSP to deal with I got a detailed reader response that arrived at this question:

Can you have too much income from dividends?

Today’s post will explore some answers to this question and of course, since this is my blog, I will offer a take on this subject as it relates to my own investing journey.

Dividends 101

First of all, let’s be clear what a dividend is and what is not. Here is one of the slides I presented during a Canadian MoneySaver webinar with my partners from 5iResearch some time ago:

Too much income from dividends

When a corporation declares a dividend, the company’s retained earnings decrease and its current liabilities increase. When the cash dividend is paid, the corporation’s cash account decreases.  Dividend payments directly reduce a company’s earnings, so only stable, well-established companies tend to make regular dividend payments.

Why would companies pay dividends at all?

Great question actually.  Companies use dividends to pass on their profits directly to shareholders. They don’t have to but many companies do.  Why?  A few reasons come to mind for me:

  • Reason #1 – it is core to company strategy. Potentially there are no current companies to acquire, maybe company debt is under control, and/or there is already a healthy stream of cash to begin funding new company products or services.  Thus, as part of company strategy to reward shareholders – the board of directors feels it’s simply one of the best things to do with company profits over time.
  • Reason #2 – the company is on sound financial ground. Most companies that pay a dividend, especially long-term (as in decades) have a stable business model.  You really can’t fake dividend payments for very long.  Companies that grow their dividend tend to have great cash flow – profits.  As an investor, it’s to your advantage to own shares in a company that makes large profits, consistently, with time. A reliable dividend is essentially one very good sign of business strength.  This is because unstable companies cannot divert profits directly to shareholders for very long.
  • Reason #3 – they want to attract investors. This is akin to company strategy.  Some investors are more speculative and like risks (note: this is not me).  Dividend-paying companies can attract a certain type of investor; one who prefers cash in hand versus the hope of capital gains.  Such investors like the idea of earning income from their investments the same way people go to work to earn an income – it’s dependable.  Over time the work is performed by their portfolio.  The portfolio will pay out MORE income over time if you reinvest dividends and/or you hold such dividend paying companies long enough whereby dividends are increased by the company every year or so.  Companies know there are investors out there who put a bias on income generated from their portfolio over growth.
  • Reason #4 – companies know investors like optionality. You see, in a perfect world, all businesses would allocate capital in a way to perfectly maximize the return on that capital.  This would be done so reinvested money would go back into the business in way that pays off immensely for the shareholder (by increasing returns over time AND by continually reducing the company’s tax burden).  But you should know by now we don’t live in a perfect world.  This means shareholders have over time demanded a dividend – for the purposes of “optionality”.  That old link I provided above tells us shareholders like optionality – and dividends provide that optionality – to give investors the choice to increase or decrease their exposure to the business.  Reinvested dividends therefore, take advantage of that optionality, to increase exposure.  Dividends taken as cash, do not.

Dividends are therefore one very important part of an investor’s total return.  An investor could technically create their own dividend (income stream) by timing the sale of their stock shares during times of market jubilance, leveraging stock price appreciation.  This may or may not appeal to some investors.

So, to the question, can you have too much income from dividends?

My answer is:  probably but that’s a great problem to have.

Let me explain.

While I believe there are great merits in owning a collection of dividend paying stocks for passive income I can see a few downsides.

  • Lack of diversification, home bias. If you’re only investing in Canada, or the U.S.,via dividend paying stocks, you might be missing out on the benefits of diversification over time – since not all companies, sectors, nor do countries move in lock-step when it comes to market returns.  This means diversification can assist investors through risk management – investors do not need to rely on any part of the market let alone any one market to fuel portfolio returns.
  • Taxable income. While Canadian dividend paying stocks are rather tax-efficient they may not be as efficient as capital gains – depending on your earned income.  In a taxable account Canadian dividend paying stocks are eligible for a dividend tax credit from our government.  This means taxation on dividends are favourable, it is a lower form of tax; lower than employment income and interest income.  Other assets, especially those that only apply to capital gains, may be even more favourably taxed.  Here is a table from one of the sites I visit frequently for tax information (no affiliation) taxtips.ca:

Too much money in dividends taxtips

In my province (Ontario) you can see that, assuming I have no other taxable income to report (e.g., employment income, pension income, interest from investments, etc.) I could theoretically earn about $50,000 per year in dividend income and pay no tax! (hint:  look at the “Canadian Dividends – Eligible” column for the marginal tax rate for earned income levels.)

Other income sources

With no specific advantage that comes with dividend investing (over any other form of investing) I believe an investor should therefore consider how to generate a healthy, diverse mix of income to cover their expenses.  Here are some income sources my wife and I will rely on in our financial future:

  1. Workplace benefits – pensions

My wife and I are both very fortunate to have some workplace pensions to draw from in our future.

Very conservatively, I anticipate my defined benefit pension pre-tax income will be more than $20,000 per year starting at age 60.  That plan has some inflation built in as an added benefit.  I anticipate my wife’s pension will be less, but again, conservatively, I suspect her defined contribution pension income will be $15,000 pre-tax per year starting at the same age.  This won’t be enough to retire on so we’ll need other income sources.

  1. Personal benefits – working in retirement?

My wife knows I never plan to retire in the traditional sense.  I will work as long as I’m physically and mentally able to, into my 60s, 70s and beyond.  This is my plan now.  Things can and may change.  I anticipate I could earn up to $10,000 per year pre-tax working at something; throughout my 60s and potentially into my 70s.

  1. Registered Retirement Savings Plan (RRSP) withdrawals

While I don’t believe you should fully trust all the big bank financial ads – you are not always richer than you think thanks to the laws of inflation and taxation at work – you probably don’t need millions of dollars saved inside your RRSP to retire modestly.

Taxtips also has a great RRSP & RRIF drawdown calculator to play with.  In doing so you can see a solid RRSP portfolio valued at $500,000, at a more traditional retirement age of 65, can deliver a solid income stream for a few decades – almost 30-years in fact using the values I put into the table.  You can insert your own numbers and play out your scenarios.

RRSP withdrawals

My wife and I are confident if we can maximize contributions to our RRSPs going-forward we should be able to earn close to $30,000 per year pre-tax from our portfolio starting in our 60s.

  1. Government benefits – CPP and OAS

Contrary to what many Canadians think, our Canada Pension Plan (CPP) is well-funded for the next 50-75 years, maybe more.  So, Canadians who have lived in Canada and have worked in Canada for the better part of their careers should expect some income from CPP.

CPP benefits are adjusted once a year, in January, based on changes over a 12-month period related to the Consumer Price Index (CPI) – the cost-of-living measure used by Statistics Canada.

Here’s when to consider taking your Canada Pension Plan benefits.

Here’s how much you might receive from the Canada Pension Plan.

Old Age Security (OAS) benefits are also based on the CPI, but are reviewed and revised quarterly.

Here’s how much you might receive from Old Age Security.

Given both CPP and OAS government benefits include some inflation protection (via CPI), I personally consider CPP and OAS very bond-like.  For this reason, I have a tilt towards equities in our personal portfolio and likely always will.  I’m not sure when I will/we will take CPP or OAS.  It will depend.  As we get closer to determining our income needs we’ll figure it out.  Conservatively, I would think most 60-somethings who have worked in Canada and lived in Canada for most of their lives should expect to earn about $1,000 pre-tax from CPP and OAS combined.  That’s a decent rule of thumb for your calculations.

Summary

What am I getting at?

Looking at the inventory above, I believe we are building towards generating a diverse income stream to fund future wants and needs – income earned via dividend paying stocks are just part of that equation.  Absolutely, to the reader’s question, you could have too much income earned from dividends (to trigger a tax headache in retirement).  Yet considering all the other issues that may come with aging gracefully I believe having a tax small problem in retirement is likely one the best problems to ever have.

What’s your take?  Can you have too much income from dividends?  Why or why not?  

Happy New Year to all readers!!

Mark Seed is the founder, editor and owner of My Own Advisor. As my own DIY financial advisor, I've grown our portfolio to over $500,000 - but there's more work to do! Our next big goal is to own a $1 million investment portfolio for an early retirement. Come follow my saving and investing journey, learn from industry experts, and win FREE stuff by subscribing to my site. Delivered by Subscribe Here to My Own Advisor

25 Responses to "Can you have too much income from dividends?"

  1. Nice summary Mark!
    My sister had most of her retirement savings in Bank Mutual’s and GIC’s. I had talked to her over the years about DG investing and 4 years ago she asked me to switch her investments to DG stocks.

    Since that time her income from her investments is almost triple. But she panicked when she lost 30% of her OAS after the second year. But what she didn’t notice was that after taxes and the loss of the OAS, her net income was still considerably higher than before. To keep her happy we moved some of her holdings to the Transfer Agents and had the dividends deposited into her bank account. Now she can see that her bank account is growing (as she’s not spending all the dividends drawn down) and that her total income and investment value is much higher.

    Personally, I don’t believe one can have too much dividend income, but one should monitor the tax effect of where one holds their highest yielding stocks. One Yield grow as companies increase their dividends over the years, dividend reinvestment and through selective purchases over time.

    Reply
  2. Hopefully I will encounter this problem one day, hahaha.

    Here is what I think I would do if in case this really happened. I will always max out my tfsa and not touch it. I will monitor my dividend income and if it’s too big, I will switch some of the asset to no distribution etfs to avoid too much tax.

    Reply
    1. Smart May. I just contributed to our TFSAs and both are maxed out again for 2018. Now, the next priority is to continue to pay down debt. Rinse and repeat next year as well, save some, invest some; kill debt. Boring approach really 🙂

      Reply
  3. Some problems are good problems to have and I actually want to have them. If someone suddenly say to me that I have a six figure retirement income and I have no RRSP to lower my taxes, I will take on this issue with a flash. On the other hand, I don’t want to even come near the question if how do I earn extra income to fund my retirement when I am old.

    Simply put, if you are fortunate enough to have this problem, here is a hint: make some accountant friends. I would rather have more money and pay a higher percentage in income tax than to have no money and to pay no taxes.

    Reply
  4. I’m going to assume the reason for this article is the “gross-up” of income derived from dividends. This gross-up can have an effect on triggering clawbacks.

    Reply
    1. I suspect that might have been the driver for the question, or the OAS clawback, but I’m not sure Lloyd so I did what I could with the post to offer a perspective on dividends as part of total return and the fact that dividends should not be looked at in isolation from other income streams, to insulate what retirees could look forward to.

      We’re a LONG ways away from retirement age but it’s something I obviously think about and write about – how to get their on financially secure footing.

      Reply
  5. Just retired this last year (2017) and I made the mistake of taking OAS too early (2015) and it is being clawed back because of my employment earnings and dividends/cap gains in non registered investment account.
    Now that I have retired I have applied for an adjustment to the clawback. Will see how fast CRA is with that. Hope the Phoenix system is not involved.
    At any rate I should not have any more clawback until I start to draw down the RRSP (RIF) and then we will see how much I will be “earning” then.
    The whole idea is to be tax efficient i.e. pay less tax. After all that was/is the whole concept of the RRSP program.
    Having said all that, if I should be so unlucky as to have revenue over the OAS threshold I will endeavour to think of how lucky I am to be in that position rather than how unlucky I am to have to pay more, or receive less, to the various governemnts.
    Is your glass half full or half empty?

    RICARDO

    Reply
    1. I agree, the whole idea is about tax efficiency however I suspect Ricardo that if you have OAS now clawed back you have saved enough money to cover most of your expenses in retirement. This an excellent problem to have, really…as you have mentioned.

      Congrats on doing so well and best wishes for 2018.

      Reply
  6. Good article and much appreciated. It would be good to also address the dividend gross-up, which is not self-evident in the http://www.taxtips.ca tax tables. And it would be good to spell out where the dividing line is between when capital gains becomes more advantageous than dividend income. Looking at the table, it appears that when taxable income is $93,2018 and above, then capital gains are more favorable.

    BTW: Taxtips.ca is a fabulous web site. It does address the dividend gross-up in it’s calculators.

    Reply
    1. Thanks Helen. I finally got around to writing it. I recall there were a few questions and comments from you and other readers – hence the post.

      I’d have to review the table in more detail, for marginal rates, but that seems about right to me. Basically, high- to higher-income earners approaching $100k (or more) in taxable income should be favouring capital gains vs. dividends to keep their portfolios more tax efficient.

      Any big investing plans for 2018?

      Reply
  7. I am in my early 70s, still working, collecting a pension from a previous employer, collecting CPP and taking the minimum RRIF payout allowable. My OAS is totally clawed back. My TFSA contribution has been max’d out as well. I am looking to making my non-registered account more tax efficient and am looking at moving to the Horizons Total Return Index family of ETFs such as HXS, HXT, HXQ etc that pay 0% in distributions or dividends. Instead, you will only be taxed with capital gains tax when you sell down the road. The dividends are still there but used to compound instead of being paid out. When it comes time for retirement and theoretically lower income, you can sell off small portions of your portfolio and only pay capital gains tax. You should also be able to claim these withdrawls as Return of Capital and pay no tax until you have used up all of your original capital investment.

    What are your thoughts on this strategy and do you see any risks?

    Reply
    1. So if I understand your issue Howie – all OAS is clawed back? I won’t share that threshold on this site but that means you have some great income for a 70-something!! Well done!

      I think for any retiree, if they don’t need the income, using the TFSA is a no-brainer. With your TFSA room maxed out and given your high income, I would definitely consider capital gains the best form of taxation for you – which means – using swapped-based Horizon ETFs might very well be smart thing to do since gains are not incurred until you sell those Horizon assets.

      I should interview one of the senior managers from Horizons that I know, and we can tackle this angle and others.

      Do you have a list of questions I should interview them with? Let me know Howie.

      Cheers,
      Mark

      Reply
  8. Having too much dividend is a good problem to have! For me I have not considered CPP and OAS in my calculation. I simply see these two as extra gravy that we might be to get when we are older. Since we plan to live abroad for a few years in the future, we probably wouldn’t be able to get the full CPP & OAS amount anyway.

    Reply
    1. Well, I have to consider it because it’s a reality. Not that I’ve always thought this way but as I get older, it’s an important consideration to figure out how to have secure, fixed-income assets (government benefits) and couple that with growing, market-linked assets such as stocks.

      I won’t be able to get the full CPP but OAS has different rules since it’s not a contributory plan. Anyhow, they need to overhaul OAS 🙂
      https://www.myownadvisor.ca/time-overhaul-old-age-security-oas-101/

      Reply
  9. I think dividends are inefficient and it is best to return based on a total return approach. If you focus or only purchase dividend paying stocks you will have lower returns as you pay tax on each dividend for decades before it is reinvested – or pay taxes with separate cash but as cash is fungible it is no difference.
    See this post on the Philosophical Economics blog on The Impact of Taxes on Investor Returns: http://www.philosophicaleconomics.com/2015/12/taxes/
    Specifically, this chart: http://i1.wp.com/www.philosophicaleconomics.com/wp-content/uploads/2015/12/taximpacts2.jpg?resize=640%2C278
    The overall market’s dividend payout ratio has been decreasing for decades and will likely continue to do so given increasing inequality and thus the louder voices of individuals with higher marginal tax rates on company dividend policy.
    The out-performance of dividend stocks is driven by other factors premiums such as ‘quality’ and focusing on these alone will likely yield a greater total return and higher level of wealth, ex. earlier retirement or retirement at the same ‘t’ with greater wealth than focusing on dividend growth investments.
    Thus, S&P 500 Quality Index > S&P 500 Dividend aristocrats, if I had to invest in one through an ETF or by owning the individual holdings.

    Reply
    1. Great comment Ray. I’m not so sure dividends are overrated but rather, dividends are simply an important part of total return.

      So, if the overall market’s dividend payout ratio is on the way down, this means more capital appreciation should occur – all things being equal. Dividends and capital appreciation I find are two heads of the same coin – you can’t have both in huge quantities.

      This makes the focus on total return ideal but I can certainly see an appeal for me to “live off dividends” to some degree in early retirement. If I find a better way of timing the market and selling off equities at ideal times then I will certainly do that and give up dividend investing. I can’t see that happening. I like the blend of both – some dividend investing and some low-cost investing via ETFs such as VTI or VYM.

      Reply
    2. Are you sure its as serious as it appears to be on the surface, Ray? Looking at some real numbers, 4% dividends at 8.9% eligible dividend tax rate is an annual tax drag of 0.36%. And for most of us, the non-registered portions of our portfolios will be on order of 50% of the total portfolio, so the rest is not affected at all by this tax drag. I don’t know how you would go to avoid dividends on anything approaching a normal Canadian portfolio. Junior resource and weed stocks all the way to retirement?

      Reply
  10. Howie’s post is intriguing. I never considered the Horizons Total Return ETFs before. Perhaps this can be the subject of another new topic and discussion; total return investing for retirees and near-retirees.

    Reply

Post Comment